PARTICIPANTS
Mark Brisley
Managing Director and Head of Dynamic Funds
Noah Blackstein
Vice President & Senior Portfolio Manager
Announcer: You are tuning in to On the Money with Dynamic Funds, a podcast series that delivers access to some of the industry's most experienced active managers and thought leaders. We're sitting down to ask them the pertinent questions to find out their insights on the market environment and navigating the investment landscape.
Mark: Noah, let's get started then with what's probably going to be the understatement of the year and just say it's obviously been a difficult year in the markets, but to what I said in my opening, you've managed money with the same investment process for close to a quarter century and been through two of the three worst bear markets in history. From your perspective right now as a growth investor, what's the most important thing for us to remember when we're going through times like this?
Noah: I think the old adage of in the short run, the market is a voting machine, the long run, it's a weighing machine. Our process is one that really focuses on the weighing machine part of it. It's much easier for us to try and figure out what this company looks like in five years, what the revenues look like, what the margins look like, what the earnings look like, and ultimately, if we can get an idea of that, we know where the stock price is going to go over time and make sure we have a wide enough buffer to be able to do that.
In the short term, I don't know what the impact of interest rates will be on this stock. I don't know the impact of the Russian invasion in terms of this stock. I'm not saying that I don't understand what oil prices or interest rates do but trying to guess the reaction of a company's fundamentals to these exogenous events is really a guessing game for a lot of people and they're caught up in all of these macro headwinds and all of these headlines. What they're missing is the bigger picture and the longer-term picture.
Whether it was the '60s or the '70s or the '80s, they've always been great growth companies who emerge from each of those decades. Whether that was on the brink of nuclear war or hyperinflation in the '70s, or everything that was going on in the 1980s with the fall of the Berlin Wall, each of those global events, each of those different interest rate regimes, there was always a group of growth stocks that were working and outperforming. Our main focus is to find those companies that drive long-term returns and try and tune out to the extent possible, the shorter-term macro noises that are going on today.
Mark: This process that you've deployed over the years, it's allowed you to find companies, as you say, that became much larger companies. When we think about names like Apple and Google, Amazon, Facebook, Chipotle, just to name a few that you've been involved with, we also think about leadership coming out of a bear market. Are you seeing new leadership come about in this particular timeframe?
Noah: Yes, This concept of new leadership really hearkens back to how growth stocks and growth works. There's a life cycle to products, there's a life cycle to companies, and extending that life cycle by bringing in new products, for example, when Apple brought in the iPhone which extended the life cycle of that company and continued that company's growth to where it is today, there are life cycles and growth eventually does mature.
When these big bear markets tend to happen, the factors that drive stock prices over long periods of time, which includes the earnings and revenue and the opportunity for those companies, continues but usually, it signals a change in leadership. The companies that led in the 1980s after the bear market in the late '80s and early '90s, the leadership changed. It wasn't IBM or Hewlett-Packard, it turned into companies like Microsoft and Cisco and, EMC.
There was a new group of stocks, sort of the leadership group of stocks. We similarly saw that in 2002 coming out of that bear market and again in 2008. Every new bull market has new leadership. I think what people tend to do though is they think, "Oh, well, this time it's going to be energy, or this time it's going to be companies that make ketchup or something like that."
It's always going to be companies delivering revenue and earnings that far exceed what the overall economy is doing. Companies with new products or new services that have the ability to grow rapidly and at multiples of where they currently are today. The names change, but those fundamental factors never change.
Mark: You've talked through your process about what leads you to buy into your portfolios with the companies that you're looking at. It's times like these though where probably it would be interesting to talk a little bit about when you would sell a position. Exiting a position may just be as important as the buying decision itself.
Noah: Theres’ a number of reasons why we would sell. When we look at what we think the long-term opportunity is for that company, and we look at where the stock is currently trading, what we're trying to do is find companies today that are undervalued relative to what they can earn in the future. We're looking at this company relative to its future earnings and opportunity is undervalued, tremendously undervalued and so when the current stock price reflects all of that future growth, it's already embedded in that stock price.
There's really no upside left for us and so if a stock is fully encapsulated or fully reflecting everything, we think that could happen on evaluation basis, then we'll move on from that company. Management mis-execution or the inability to deliver, there are many companies that have the similar opportunity, but execution and management matter a lot and so look at the difference between an Apple and a Blackberry. Look at the difference between Google and Yahoo.
You could be in the right race but on the wrong horse and what you want to make sure is that the companies that you're in are executing and delivering to that longer-term vision, and if they're not, you want to move on and find the company that is executing and delivering on that overall vision. Those are some of the reasons why we would sell a security. Other than regular portfolio management, we tend to own 20 to 25 names in the portfolio fairly concentrated and so certain positions can get to be large positions.
Just as a risk control measurement, we may pull them back after a big run. If it's become a too large of a position, we might bring it back down. Our average position size is around 4 to 6% of the portfolio, and if it exceeds that by a large amount, we might bring it back in, and that's not really selling the security or having a negative view of the company, that's just managing overall exposures of the fund, which matter in a concentrated portfolio.
Mark: Listening to you talk about the fact that at the end of the day, you invest by looking at companies and trying to determine how much larger they can become. We know that that means you're not a macro investor, but the macroeconomic climate has been so noisy, so impactful. We know you're aware of that environment, so how much of an impact have the macro factors and in particular the Fed had on market performance in 2022 and on you as an investor?
Noah: The impact of macroeconomics and federal reserve moves. One of the most recent data dumps that I recently saw was roughly 80% of stock price movements are based on macro factors since the COVID pandemic and so we've really seen fundamental factors of individual companies get swamped first by COVID stimulus then followed by just probably one of the most aggressive rate tightening regimes we've seen in a very long period of time.
We've gone from basically 0 to 425 basis points in an incredibly short period of time along with quantitative easing, so macro has mattered, is the only thing that's mattered this year, and it mattered in terms of slope of the yield curve and how investors reacted to that. Now it's mattering into the investors believing the recession is coming, even though we haven't seen one yet and so what's driving stock prices, even though the companies have executed, they've delivered, they've reiterated their outlooks, it hasn't really mattered.
You've seen massive multiple compression across the market this year, especially in the growth sectors. In terms of the number of growth stocks outperforming the overall market. In the spring of this year, less than 12% of growth stocks were outperforming the market. It's a number we've never seen before, going back to all the data so because all the stocks are trading as one, it tells you, it's overly influenced by what's going on in the macro investors using factors or other things to whip around securities.
It also suggests that babies are being tossed out with the bathwater. That's where the opportunity for active managers is because over the long run, we're back to that weighing machine and the ones with real growth and real opportunity will be significantly higher than where they are today and that's our opportunity,
Mark: I guess in some respects that makes it hard to also not try and capitalize on momentum. We've talked about the fact that most sectors for the market and the S&P 500 and MSCI have been down this year with the exception of energy. Where are you seeing growth stock valuations versus where they've been historically and is this actually providing opportunity for you right now?
Noah: When we look at some of the benchmarks that we use for growth stocks, and we go all the way back to the beginning of the data in 1960, on a relative price of sales basis, which is how we tend to look at it, not on a price to earnings basis because that can be influenced by accounting treatment, that can be influenced by different tax rates, a whole bunch of things that can go into the E but the price of the sales is what's consistent over time.
Growth stocks, this is the lowest level going back of all the data of growth stock valuation to the overall market. They've never been cheaper on a relative basis, ever. They've all been swooped down in this big drawdown that we're seeing today. It's quite remarkable, actually.
Mark: Growth is on sale is not an unreasonable comment?
Noah: Yes, we're trying to find stocks that are undervalued relative to their opportunities or future growth. There are a lot of companies that are undervalued. Even on current earnings or next year's earnings and stuff like that, there are a lot of undervalued companies with very, very high margins and long-term secular growth outlooks that aren't just undervalued relative to where they're in the future, they're undervalued as to where they are today.
Mark: One of the other topics of the day, and I guess shame on me for not bringing it up already, is the inflation subject. We're hoping it doesn't stay high for an extended period of time and think that's very unlikely. Can certain stocks, and in particular, growth stocks do well in this type of environment? Where are you seeing things right now with respect to inflation?
Noah: We're not really macro investors, and we try not to get all caught up in that. This time last year everyone was talking about transitory, but now, for some reason, we're in the 1970s and everyone is Paul Volcker, neither of which were true. This isn't true and the transitory nature of some of the past few wasn't as well. Having said all that, interest rates have gone up a lot. A lot of the drivers of inflation have rolled over hard, especially goods inflation, whether that was in used cars or in other things like that.
We're starting to see the beginning of inflation falling in rents. All I can tell you is that we're a macro-driven market, which has been the major frustration for me as a bottom-up stockbroker this year. You can see the moves that growth funds had on that one lower than expectation CPI miss. There were gargantuan moves in a single day. You can see the macro type of environment that we're involved with right now and how small changes on the margin can have major impacts on the overall valuation.
I can't time that. I don't have a clue on that. I don't know when that's going to happen or what's going to happen. Thus far, we're not in a recession. I can't time those macro factors. I don't know when inflation begins to abate, when the jobs number comes in weaker than expected. All of those things are going to have a pronounced impact on a lot of the valuation of certain stocks.
When that happens, why that happens, how that happens, we just want to make sure that we're in the right companies for the next five years. Those shorter-term trading decisions are just not things that we can be overly concerned about, but there's a lot of inflation that's behind us now.
Mark: Is there any concern or, I guess, attention paid though from your perspective to the health of the consumer? I ask that question because I think the direction here is it's difficult for a lot of people to think about staying invested right now during volatility and in a bear market situation like we're in. When you hear names, companies like Amazon, great big companies that are going through lay-offs and that whole Main Street, Bay Street, Wall Street comparison, there's actual real pain over there because of things like inflation.
Noah: For sure. No one's dismissing the pain that it caused. You put a lot of stimulus into the system in the trillions of dollars, you locked people up in their homes, and they only had one thing to spend on, which was goods, and at the same time, COVID discontinuing in China with shutdowns and supply chain issues. There's a cascading effect of all these things huddled on one another in terms of inflation.
When it abates and how it abates now that rates have gone up, now that housing has corrected or starting to correct, if that is the one thing that's been pressuring growth stocks, if that eases, what I'm suggesting is that perhaps the train now is we're worried we're going into a recession and everything's going to be bad, maybe that's it.
You also have to ask yourself when you're looking at certain stocks, "What's in the price?" For example, since October, semiconductor stocks whose fundamentals are challenged, with excess inventory and waning demand, have moved a lot off the bottom. In some cases up to 40% off the bottom on these stocks, which were being dumped nonstop.
The stock market is forward-looking. If you're waiting for the picture to become all clear over the next six months, that's not how the market works.
The market looks through things if it can see its way out the other end. That's why we try and take a long-term view to what we're doing. Yes, there's been pain that's reflected in stock prices, many of the things on inflation are rolling over. Yes, job layoffs will pick up, though so far, the labor market has remained resilient, both in Canada and the United States.
That will change and loosen up for sure. As far as we can tell, though, from our perspective, if you get bad numbers and stocks go up, the market is looking forward, the market is looking at what the next factor is. How we think is make sure you have the five-year view correct and understand some of these macro influences. Be aware of the short-term. If the company is not executing, if the company is not delivering, you don't want to be in a Yahoo, if there's a Google. You don't want to be in a Blackberry, if there's an Apple.
Similarly, you want to make sure that the management team are delivering and executing. You don't want to let short-term unpredictable macroeconomics, which even if you get right, you don't know what the impact on the stock will be. I remember investors telling us that if Donald Trump won the presidency, the stock market was going to collapse and that night, the Nikkei futures were down 8%. Then we basically went straight up from 2016 until 2018.
A lot of these things just because you have the narrative right doesn't mean you have the reaction right. That's why we're focused on the weighing part of this market, and the long-term fundamentals. We're not guessing at macroeconomics. When that turns, it's going to turn exceptionally fast as we saw most recently with the CPI number. We can't predict it, we can't time it, all we can do is what we've done for the last 25 years plus, stick to our discipline, stick to our process, and know that over time, that's what works in terms of delivering returns to shareholders and unit holders.
Mark: Being a true growth investor, it's understood that you're not investing in companies for their dividends. However, dividends, and yield, and income, continue to be significant topics. That said, number of stocks with dividend yields like right now would be lower than a 10-year Treasury is at the same levels that we saw back in the global financial crisis. Does that hold any significance for you or tell you anything?
Noah: I think what you're saying is that if you look today, the number of stocks with a dividend yield higher than the 10-year Treasury is very low.
Mark: Very low.
Noah: Typically, since '08 when the market has fallen stocks have had a better dividend yield than the 10-year Treasury because the yields have been so low. This rate hike cycle and the move of the yield curve have basically got us back to a pre-global financial crisis where there's not that as many stocks with yields above it. I do think something's different this time. I think, obviously, short-term interest rates are much higher, and cash does have a yield. Cash is an asset class again.
If you want to move to cash and earn 4%, and take that income portion of your portfolio, and have zero beta on it, I understand that. In fact, in our Power Global Balanced Fund, we've moved our fixed income into very short-term money instruments that are yielding close to 4% currently. That can change but it is currently yielding that because now with bonds down double digits this year, we now have an opportunity to earn yield with no beta.
What that affords us is the opportunity to go out a little further on the equity side. You don't want to outlive your own money and you can do that if the capital is not appreciating. It's just earning a yield. We've moved our asset allocation a little higher on the equity side and substituting higher-yielding cash for fixed income. It is a little bit different. We haven't seen since pre-global financial crisis cash with the yield on it and that can change asset allocation. I've always believed in two asset classes, cash and growth stocks. Now in the power global balance, we can do that a little bit more. That's the opportunity on the equity side, for sure.
Mark: So much of the work that you've done over the years has led you to groups or themes with respect to the companies you've invested in. One of those as an example was investing into cloud-based enterprises. Are there any areas right now where you're seeing, or your investment process is uncovering or finding opportunity for you given the conditions we're in?
Noah: All of our themes in the portfolio come from the bottom up. It starts with our process of finding companies, growing high teens or better revenue and earnings and then doing the fundamental work on the companies to measure the length and the width of the runway that those companies have in front of them. When we do that, we'll look at this number of companies that are helping corporations digitally transform their businesses and shift to the cloud. Oh, look at the number of companies that are in the solar space that are solving issues in terms of energy reliability and independence in Europe, at the same time, benefiting from the US has pushed toward green energy. What you'll see is there are themes in the portfolio, but they're all driven from the bottom-up. That move toward cloud is still in its early stages and has a long way to go. More intelligence is going to occur in the cloud.
We're probably on the cusp of making AI, artificial intelligence, usable on the enterprise-wide level so corporations can build more applications and use artificial intelligence to get better at what they do, whether that's from a sales and marketing perspective, or data analytics. In terms of other things in the consumer space, it's always been the restaurant where the retailer that can expand stores or has a new brand or opportunity. In healthcare, it's always really idiosyncratically driven.
It tends to be one company being driven by a new product or service or buy a new drug that hits the market to meet an unmet need. In both those cases, I think in health care whether that's through continuous glucose monitoring, and other personalized health care that's attached to your body where you can monitor a whole host of conditions, that came from the pandemic, and that's probably going to continue out there but in terms of pharmaceuticals, we're on the cusp of drugs now for probably obesity, and Alzheimer's.
We're not there from the bottom-up perspective yet, but the opportunity ahead of us for those companies is, especially in the case of dementia and Alzheimer's is the single largest unmet pharmaceutical need in the world today.
Mark: Seems to continue to be a lot of conversation around things that accelerated or benefited from the pandemic, which is almost an awful way of saying something but can there still be growth found in those particular areas, or are we moving on to post-pandemic world and new areas of interest and opportunity?
Noah: I think the companies that have suffered the most are the ones who believed there are permanently higher plateau for growth because of the pandemic. A company like Peloton just did whatever they could to meet the pandemic demand, not realizing it would wane once reopening, and most of that demand was met. You see that in e-commerce as well but you're also beginning to see the early stages of some of those companies were pandemic beneficiaries who were hit first in this bear market in 2021, not 2022.
Those companies begin to emerge now from the ashes of the pandemic who have been able to hold on to customers, or whose competition was in the private equity market and those competitors are being shut down by private equity, who are now beginning to accelerate their business coming out of this from both a revenue and profitability standpoint. If the companies meet our criteria for growth and revenue and earnings and profitability, we're certainly going to look at them.
Dismissing everyone who benefited from the pandemic and not saying that there will be some winners who will be able to sustain that growth, who have held on to customers, or who will benefit from the competitors in that space being shut down in the private equity world would be naive. We look everywhere for companies, we're not dismissive of anything. If the numbers of revenue and earnings are there, we're going to look.
Mark: Well, thinking about the next five years, but even hearing you speak today in a post-pandemic world, in the middle of a bear market, there's a lot of optimism in your voice in your outlook. Are you excited about what you're seeing right now, and a couple of final comments to our listeners on investing in this environment and holding course?
Noah: As somebody who has a lot of money in his own funds, I can tell you, I understand how difficult these markets have been but also doing what I'm doing for so long and having been through these types of markets, they're always a little bit different. 2001, 2002 was not like 2008, and 2020 was not like 2008 nor is '22 like 2008, or even '01 or '02. It's always a little bit different going through these periods of times with the cause, or what changes it but what doesn't change over time is companies that have that opportunity to be significantly bigger, who are part and parcel of these secular growth drivers in the overall markets exist today.
Just they like existed in 1974. Just like they existed in 1982. Just like they existed in 1991, 2002, 2008, or 2020. We're very excited about the next five years. I have no idea when the turn occurs. It's very macro-driven, not fundamentally driven. I do know that the upside over the next five years from what we see in the companies, obviously, management teams need to execute.
The federal reserve can't just go completely out of their minds in putting us into a deep recession. From what we see in terms of opportunity and upside, whether it was the low of '02 or the low of '08, or even '98 or a whole host of bear markets. This is as good as it gets in terms of upside of secular growth companies over the next five years in my opinion, and my opinion I think is worth something. I've been doing this a very long time.
[00:26:02] [END OF AUDIO]
